Recent reports on housing starts, new home sales and housing prices show that the housing recovery continues.

The housing crash is the single most important factor that started this recession, so it would be nice to know when it will end.

Although the housing inventory exceeded the demand in 2007 and 2008, we have known for a while that the fundamental supply and demand ingredients would permit a genuine housing recovery to begin in 2009. As demand caught up, housing prices stopped falling and stabilized at more normal levels.

Although housing prices should not be expected to return to their 2005 peak any time soon, housing sector data released last week suggest that housing prices can head somewhat higher. Housing permits and housing starts have continued higher in the last couple of months. New home sales were higher in March than they had been for a while.

Although the Case-Shiller home price index for January and February was slightly lower than it was at the end of 2009, the message was somewhat different from a government report last week on the producer price index for single-unit residential construction through March 2010. That index measures the average change over time in the cost of materials for making new homes. The chart below displays the index for each month since January 2008. The index has increased 3 percent since last summer, when it was 5 percent off its high.

The producer price index is of economic interest because it is an important determinant of the prices of existing homes. Few people want to pay more for an existing house than they would pay for having one built new. As a result, the housing producer price index is an important ingredient for economic forecasts of housing prices.

Inflation hawks may say that the housing producer price index is a harbinger of economywide inflation to come. It’s quite possible that inflation-adjusted housing prices will not significantly increase, but even a housing price increase resulted merely from general inflation, would be welcome, because anything that raises housing prices can help alleviate the extraordinary prevalence of foreclosures that derives largely from the fact that debt-strapped homeowners can no longer sell their homes for enough to cover their mortgage.

That’s one reason why it was good news last week that the costs and amounts of housing construction continue to rise.

Thursday, April 22, 2010

Higher nominal housing prices would improve economic efficiency, and the costs of construction are an important determinant of housing prices. The big news today is that construction costs are significantly higher than they were 9 months ago.

The chart below shows how construction costs stopped falling in the first half 2009, and now have increased significantly. Today's BLS estimate of Mar 2010 construction costs is part of the increase; another part comes from recent BLS revisions of the 2009 data (for pre-revision data, see here).

For those who want to work further on the visibility of taxes, you will find this note I received to be of interest. The "visibility" hypothesis is seductive, but never confirmed with actual observations - the best kind of topic for research!

emailed to me from bgalle at law.gwu.edu:

"I've made similar claims [that visible taxes do not help restrain spending], albeit informally (not mathematically modeled) and in fora not usually of interest to economists (i.e., in law journals).

I'm also interested in modeling these intuitions more rigorously, as well as testing them empirically, but my own math skills are more suited to discussing rather than crafting such work. If you have or know of graduate students with similar interests, please feel free to put them in touch.

Many thanks.

Best,Brian

Brian GalleVisiting Associate ProfessorGeorge Washington University Law School (2009-10)

Opponents of the value-added tax complain that it is not sufficiently visible to voters, and is thereby an obstacle to responsible public spending. But in fact government spending is no lower in countries with more visible taxes.

Last week I explained how reforming the income tax system — perhaps by replacing it with a more efficient value-added tax (VAT) — might fuel further growth in government spending because less efficient taxes create more political pressure against big government.

Some economists agree with my conclusion, but for a different reason. Because the VAT is collected at each stage of production and, unlike our state and local sales taxes, is not shown to consumers separately from purchase prices, it has been said that VATs are not visible enough to voters to create much electoral resistance to raising their rates.

John Kass of The Chicago Tribune even suggested perhaps the ultimate in tax visibility — that income taxes be collected only once per year: the day before election day.

The pattern of social security taxes across countries provides a test of these theories, because countries differ in how they collect public pension payroll taxes. Some countries, such as the Netherlands, take most of the tax out of employee paychecks, while others, such as France, levy most of the payroll tax on employers. The United States and several other countries take an equal amount from employee paychecks and from employers.

Payroll taxes are no less efficient if they are taken from employers rather than employees, but the taxes on employees are clearly more visible to employees. Indeed, economists themselves sometimes forget that their employer is liable for payroll taxes on their behalf!

Interestingly, democracies collect the payroll tax more visibly (that is, a greater share from employee paychecks) than nondemocracies do. But countries that put more of the tax on employees do not manage to spend less on public pensions (Social Security, as we call it in the United States).

The scatter diagram below shows public pension spending as a percentage of gross domestic product, versus the fraction of payroll taxes levied on employees rather than employers. Countries such as the United States with equal payments by employers and employees are shown up the middle of the chart: they all have an employee share of 0.5 but each has its own different propensity to spend on public pensions.

If more visible payroll taxes helped restrain payroll taxation, then we should see countries that take relatively more of the payroll tax from employees rather than employers — those in the right part of the chart — spending less of their G.D.P. on the public pensions for which these taxes are earmarked.

Instead, the correlation between the two variables is essentially zero (neither economically nor statistically significant). This result holds up when adjusting for a host of other variables that determine public pension spending, and excluding the Netherlands (an apparent outlier in its payroll tax collection).

I am not especially surprised that tax visibility is empirically unrelated to the amount of taxation and government spending, because the impressions of voters who see the more visible taxes are by no means the only determinant of government spending. Special interests matter too.

In the case of the payroll tax, one of the important interest groups would be the employers themselves, who are of course quite aware of payroll taxes levied upon them. Employers may even resist such taxes more if they thought those taxes were invisible to, and thereby unappreciated by, their employees.

It is wise to consider how transforming our tax system might affect the propensity of government to spend. But making taxes more visible to voters would be all show, and deliver no results.

The personal income tax is an administrative and economic burden. But those burdens have an overlooked, and potentially beneficial, side effect.

Millions of Americans are spending hours of their time this week completing their personal income tax returns. Economists believe a simpler tax code would eliminate such burdens, not to mention the burdens to the economy created by various kinds of tax-sheltering behavior that would make little economic sense with a simpler tax code.

But it’s easy to overlook an important side-effect of tax complexity burdens — and the taxpayer anger created by them. Such aggravation helps sustain the sizable and energetic group of Americans who want their government to get by with less.

As President Obama’s head of the National Economic Council, Lawrence Summers, once wrote, “A better tax system may lead to more wasteful spending.” Even Professors Robert E. Hall and Alvin Rabushka, longtime advocates of simpler tax code, concede that a simpler tax makes it much easier for advocates of larger government spending programs to be successful. (See p. 48 of their book.)

By comparison with the income tax, the payroll tax is quite simple, and readily confirms the claims that a simple tax is a tax that will be used as a government revenue machine.

The payroll tax has absolutely no deductions — not for charitable contributions, mortgage interest, college tuition and the dozens of other activities favored by the income tax — and collects almost as much revenue as the personal income tax, despite the fact that the payroll tax rate is less than 15 percent.

For years, taxpayers have been frustrated by the personal income tax, and politicians from John F. Kennedy to Ronald Reagan to George W. Bush tried to pacify them with cuts in the personal income tax rates.

But the payroll tax generates much less complaining, and it’s no accident that the payroll tax rate has been increased 19 times (20, if you count the health care overhaul that was just passed), and cut exactly zero times. There is no real political fervor for cutting the payroll tax, or energetically resisting payroll tax increases.

So we could eliminate some of your perennial mid-April frustration by replacing the income tax with a simpler and more efficient tax code, but in that case be prepared to send a greater fraction of your income to the United States Treasury.

Tuesday, April 13, 2010

Professor von Wachter et al: extended benefits account for about a percentage point. Professor von Wachter said this in his presentation at the Univ. of Chicago -- I'm not sure how clear the working paper is on this point. He also qualified his prediction -- he is studying Germany, not the U.S., etc. -- but he was very clear that longer benefit eligibility results in more time unemployed.

Professors Elsby et al, writing for Brookings: UI could account for “as much as 15 to 40 percent of the rise in aggregate unemployment duration, a potentially substantial effect. In terms of the unemployment rate, this corresponds to between 0.7 and 1.8 percentage points of the 5.5 percentage point rise in the unemployment rate witnessed in the current recession.”

Dr. Feroli at JPMorgan: extended benefits account for 1.5 percentage points of the current unemployment rate

Federal Reserve Board: "The several extensions of emergency unemployment benefits appear to have raised the measured unemployment rate" (Jan 2010 FOMC minutes). They cite other estimates, which could overlap with the above.

For my own decomposition of the "offsetting" effects of UI, see this post from last summer.

I am well aware that the Meyer study and the study of Pittsburgh are "partial equilibrium" -- in theory it is conceivable that one person's work behavior is offset (or more than offset) by the work decisions of others. Indeed, I have given a great deal of attention to empirically estimating the feedback effect, and found (in this paper, this post, and the posts linked therein) that an increase in labor supply of one group is not fully offset by decreases in labor demand for other groups, but rather increases aggregate labor usage (as partial equilibrium theory would predict).

Although a bunch of economists proclaim that UI's general equilibrium effect offsets its partial equilibrium effect, they have put forward zero evidence in support. It is my opinion that unemployment insurance significantly raises unemployment and significantly reduces employment, even after accounting for general equilibrium effects. Whether that's good or bad is another question.

Saturday, April 10, 2010

Earlier I displayed some data on output and factor usage in the manufacturing and home construction industries. Those were clearly cases of lack of demand: people wanted to buy less of those items, so suppliers produced less of them and used less capital and labor in the process. It's no surprise that, say, a 20 percent reduction in what customers purchase would reduce usage of labor and capital by about 20 percent.

Manufacturing and home construction together were only about 15 percent of the overall private sector, so it worthwhile to look at the rest of the private sector industries. The chart below shows that rest of the industries are STILL PRODUCING at pre-recession levels. Unlike the home construction and manufacturing industries, these industries cannot (on average) blame their drastic labor cuts on a lack of production: they are still producing and earning real incomes like before, but have decided to do so with a much smaller workforce.

Friday, April 9, 2010

Economic theory suggests that marginal product of capital series might help predict economic growth forward one or two years, even under abnormal conditions such as wartime or depression. In some situations, the marginal product of capital is an essential ingredient in cost-benefit analyses (Harberger 1968; Byatt, et al., 2006; Mityakov and Ruehl, 2009). Evidence on the marginal product of capital can also help test various explanations for business cycles, and help identify causes and consequences of the recent housing “bubble.” The purpose of this paper with Luke Threinen is to produce annual and quarterly estimates of the marginal product of capital (net of depreciation), one each for the residential and nonresidential sectors of the U.S. economy.

By definition, the marginal product of capital net of depreciation is the change in net domestic product (NDP) during the accounting period (e.g., one quarter) that would result from an increase in the beginning-of-period capital stock of $1 worth of capital. In particular, the additional $1 of capital would have the same composition as the rest of the capital stock. For example, if the economy’s capital consisted of 400 identical structures and 100 identical vehicles, each of which cost $2 to acquire, then the marginal product of capital would be the extra NDP attained by starting the quarter with 400.4 identical structures and 100.1 identical vehicles (that is, $0.80 worth of structures and $0.20 worth of vehicles).

Suppose that origins of the current recession could be traced back to limits on the supply of aggregate investment due to a “credit crunch.” In fact real investment fell through the first year and a half of this recession, but the credit crunch theory says that the marginal product of capital would rise as a consequence of the increased cost of capital faced by those with new capital projects. Alternatively, financial crisis or something else could reduce labor usage more directly, and, given the complementarity of labor and non-residential capital in production, non-residential investment would merely respond to low marginal products of capital, thereby putting the non-residential capital stock on a path that is consistent with a lesser amount of labor usage (Mulligan, 2010).

The marginal product of capital is also interesting as an aggregate leading indicator of business conditions, which is the motivation for its use in a number of studies (e.g., Feldstein and Summers (1977), Auerbach (1983)). This relationship alone may make it a predictor of subsequent economic growth.

Additionally, Fisherian consumption-saving theory suggests that the marginal product of capital, or variations of it, should predict consumption growth.

Over the last ten years, the marginal and average products of residential capital fell, and then increased, as housing construction was booming and busting. In this sense, the residential data suggests that the supply of residential capital shifted along a relatively stable demand for the services of that capital. As indicated by the marginal product of residential capital at the end of 2009, current housing supply seems restricted by comparison with the housing boom (when the residential MPK was low), but fairly normal by comparison with the 1990s when the residential MPK was similar to what is was at the end of 2009. These patterns are consistent with the findings of Davis, Lehnert, and Martin (2008) and others that housing rent-price ratios were low during the housing boom, and with the conclusions that the housing boom was fueled by optimistic expectations, or by easy credit.

The marginal product of non-residential capital was much higher during the housing boom than it was during the recession, when rates of investment in non-residential equipment and software were low. In this sense, the supply of non-residential capital seems less restricted during the recession than it was before. In other words, the recession’s investment rates may have been low because of a slack labor market, rather than the other way around. In any case, the testing of various theories of this recession, and the prior housing cycle, can be enhanced with marginal products data like those shown in this paper.

Wednesday, April 7, 2010

Labor unions are among President Obama’s political allies, and were actors in the story of the demise of General Motors. But I do not yet see much evidence that their influence on private-sector outcomes has become more significant.

Determining which of these characterizations is generally correct is a complicated task, and well beyond the scope of a short non-technical blog post. Moreover, the measurement of output and productivity in the public sector — where somewhat more union members are employed — is difficult. But we can more easily address the question of whether the private-sector influence of labor unions has changed over the past couple of years.

If unions’ newfound political success was associated with additional influence in the private sector, then they might have succeeded in obtaining additional wage gains for their members, or at least in preventing wage reductions that would have occurred without a union.

Economists debate whether unions obtain wage gains solely by restricting employment and work hours, or whether unions have some success at maintaining employment at the same time that they obtain better pay and benefits for their members. European economies offer some evidence for the latter, because employee incomes increased faster than gross domestic product during the decades that unions were gaining influence there.

Thus, if private-sector unions recently wielded more influence, we would expect the employee share of national income to rise, at least in the short run.

The chart below shows the ratio of employee income, including cash compensation and the value of fringe benefits, to total income in the private sector, on a quarterly basis since 2005 as measured by the Bureau of Economic Analysis. The self-employed are excluded from the calculation because such people serve as both owner and employee.

The Bureau of Economic Analysis data show that the employee share has fallen in four consecutive quarters, and is lower than it has been for years. While it is nice to acquire an ally in the Oval Office, private-sector unions probably lost influence during this recession.

Monday, April 5, 2010

The U.S. government could honor President Ronald Reagan by circulating $500 bills again, and putting his picture on them.

Obviously having his picture would be a honor. But having $500 bills in circulation would help citizens further evade the taxes that feed an ever more voracious government: an outcome that President Reagan might also have appreciated.

A wide range of economists have said that employment is low right now because of a lack of demand. As you might guess from the title of this blog, I think supply is more important.

Let's look at two industries where I agree that lack of demand is dominant: manufacturing and residential building.

In my view, people spend less as a CONSEQUENCE of problems of supply -- they recognize that their incomes will be low so that spend less especially on durable goods like cars. While the entire economy suffers from a lack of supply, specific industries like manufacturing are disproportionately affected, so to them the recession is in fact largely a lack of demand.

I also agree with the consensus that, in hindsight, there was too much housing in 2006, so demand for residential building has crashed since then.

A lack of demand will reduce relative prices in the affected industries. A lack of demand will reduce output and factor usage in about the same proportion. In fact, that's what we see in manufacturing and construction. If anything, labor usage in those industries fell less relative to trend than output did.

If all industries suffered from a lack of demand, we would see economy-wide labor usage and output falling in about the same proportion.

But you cannot draw the same charts for the economy as a whole, because output and aggregate spending fell much less than labor usage did. Yes, construction, manufacturing, and some other industries suffer from a lack of demand. But problems with the labor market are the primary reason why employment has fallen economy-wide.

Saturday, April 3, 2010

My view is that investment fell largely because labor fell (and labor and capital are complements). For example, if fewer people are to be working, it's time to slow down the building of new office buildings and factories in which they would work.

An alternative view is that businesses were actually hungry for loans to finance new investment, but that banks were in such a chaos that loans were not available. So workers who would have worked with the new capital are out of a job.

Under that alternative view, the unemployment rate for CAPITAL should be low (and its marginal product should be high -- more on that later), because businesses would work their existing capital harder as an imperfect substitute for having the new capital that they really desire. But the chart below shows that the opposite was true -- capital was under utilized during the recession.

My view explains why the unemployment rates of labor and capital BOTH increased for two straight years: fewer workers means a lower marginal product of capital (and a higher marginal product of labor) and thereby less capital utilization.

There may be yet another theory explaining some of these facts, but I am not aware of an explanation for all four:

Friday, April 2, 2010

I made these forecasts last fall, and this week we had the release of another month of consumption data (Feb 2010) plus another month of labor data (Mar 2010). (Recall that the "partial recovery" scenario -- green series in Figure 5b -- is the one I thought would actually happen, in part because it was the only one consist with consumption patterns in 2008).

Supply and Demand (in that order)

The basic tools of supply and demand help immensely to understand and predict everyday events in our world. These days, many of those events are related to the Redistribution Recession of 2008-9. But I also look at other issues related to fiscal policy, labor economics, and industrial organization.